Pound Sterling jumps against the euro and dollar after British inflation exceeds expectations

BOE

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The pound-to-euro exchange rate reached its highest level since March, at 1.1736, after UK inflation fell to an annual rate of 2.3% in April, a figure higher than the market and the Bank of England had expected (2.1%).

The all-important and much-watched component of inflation in the services sector was noticeably higher than expected at 5.9%, while the market and the Bank of England had expected a value of 5.5%.

The chance of a rate cut at the Bank of England in June is now considerably lower than 50%, while it was almost 60% a few days earlier. The rise in the value of the pound reflects this adjustment in expectations for Bank of England policy.

The pound rose against all its peers in the G10 in the wake of the release, with the pound to dollar exchange rate reaching 1.2745, its highest level since March 21. “The market reacted to the news. Sterling rose against the dollar to a peak of $1.2759 from $1.2707 before returning to $1.2735. Markets are now not pricing in a full cut until November , compared to the previous August,” said Gabriella Dickens, G7 economist at AXA Investment Managers.



Those who read Pound Sterling Live’s recent article on Andrew Sentance’s views, which warned of an upside shock, will be prepared for the possibility of an upside surprise. “My forecast for core inflation and services inflation was largely correct. I predict core inflation of 3.8% – the actual figure was 3.9%. My forecast for services inflation was 6% versus 5.9% actual. Measures of underlying inflation have been much higher than market consensus,” Sentance said after the publication.

The outcome, meanwhile, lowers the tail risk to the pound of a series of successive rate cuts in the summer. “Will the Central Bank cut spending in June, or will it take advantage of slightly higher-than-expected inflation and wait until the August meeting? Movements in currency markets this morning suggest that a cut in August has become slightly more likely,” says Nicholas Hyett, investment manager at Wealth Club.

“UK inflation is now 2.3% below the G20 average – which it will remain for the rest of the summer – but the symbolism of above 2% will delay some of the more strident political calls for austerity for a month or two ,” says Simon. French, an economist at Panmure Gordon.


Above: GBP has hit new multi-week highs against the dollar and euro. Track GBP/AUD with your own custom rate alerts. Set here


He explains that the 5.9% services inflation is the most consequential aspect of the report, as it proves that non-tradable components are proving to be more persistent than hoped. “We are sticking with August for the first rate cut, although there will be another round of wage and price data before June MPC,” French said.

“Today’s publication was a significant blow to the BoE and the Prime Minister,” said Paul Dales, chief Britain economist at Capital Economics. “Even though there is still a pay and CPI release to go before the BoE meeting on June 20, it feels like a cut then now looks very unlikely. Even a cut in August looks a bit more doubtful.”

Looking at the details, it was the decline in household energy bills in April that provided the main downward push to inflation. Falling food prices also weighed. There was also a notable decline in inflation of clothing, footwear and alcoholic beverages.


Image courtesy of the BRC.


As the chart above shows, service industries such as restaurants and hotels continue to push prices up. This will reflect the high wage costs faced by such industries and highlights that inflation will only return to the 2.0% target on a sustainable basis if wages cool.

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